Opportunities await savvy investors

This article was contributed and first published in TODAY on 15 February 2013.

The latest round of property cooling measures announced on Jan 11 triggered a sell-off in the shares of developers as analysts predicted a drop in private housing prices, but opportunities await tax-savvy investors, who may find the post-curb market not as inhospitable as initially perceived.

There’s no question that real estate has proven itself to be a sustainable asset class. Yet the additional buyer’s stamp duty (ABSD) of 5 to 7 per cent and the 25 per cent minimum cash downpayment — among other new measures imposed last month — pose an obstacle to investors looking to purchase local property.

Different asset classes

Investors can turn to the stock market as an alternative asset class to invest their funds even as some property counters have been directly hit by the new measures. Property-related stocks such as real estate investment trusts (REITs) could benefit from this new demand.

And while some investors may choose to head overseas, others will remain focused on Singapore and explore other options in the property market such as strata office space, which saw rising demand last year. While they may not offer the same level of capital appreciation in the short term compared to industrial properties, strata offices and retail space could become the next asset class to be chased after by investors.

Medical suites are another asset class not to be missed out on. Although this is a relatively new investment class, it is set to grow as more medical tourists arrive.

In addition, owners of office blocks who are anticipating downward rental trends and tighter bank loan policies could consider strata-titling their property. While they may have initially made their office property purchase with the goal of long-term capital appreciation, such a strategic readjustment could be beneficial. Holding on to several units, selling some others and renting out the rest will ensure greater stability in the event that the bank refuses to extend a loan.

From a tax perspective, the issue is whether the resultant gain from a sale qualifies as a capital gain, which is not taxable in Singapore, or is regarded as a change in intention from long-term investment to trading.

If it is the latter, the gain may be taxed as trading income, leading to the inevitable question — whether it is possible to step up the cost base, based on the market value of the property at the point of change in intentions? This can be tricky, given that the market is so volatile now that determining the exact date on which investment intentions have changed can make a huge difference in the step-up cost base.

To illustrate, let’s assume an office block was acquired in 2008 for long-term investment purposes. Two years down the road, the owner decides to strata-title the property and sell the units, and let’s assume that this constitutes a change of intention from long-term investment to trading. Typically, the point in time at which the decision to strata-title the building is made would be taken as the date of the change in the intention, and the market value as at that date should form the base at which the subsequent gain is to be computed.

Unexpected consequences

While many analysts expect private home prices to take a hit from the new curbs, the measures could have effects that go beyond their original intent.

There will be some Permanent Residents (PRs) who are priced out of the private property market due to the 5 per cent ABSD levied on their first residential purchase, which forms an additional and irrecoverable cash outlay. Their only options would be to turn to the rental market or to purchase a resale Housing and Development Board (HDB) flat.

With the resale flat supply being limited, this increased demand may result in higher HDB resale prices in the long run, despite predictions that the Cash-Over-Valuation component will fall in response to the lower mortgage servicing ratio (MSR) for loans.

Another consequence is that the average Singaporean will find it more difficult to invest in real estate for retirement, particularly if he or she is not cash-rich. The wealthy will be able to continue investing for the long term, even with the ABSD and reduced MSR.

Furthermore, tax-savvy investors would know that when it comes to acquiring property in Singapore, whether it is booked as an asset deal or a share deal can make a great deal of difference in acquisition costs and exit tax consequences.

In the case of residential properties, particularly with the imposition of seller’s stamp duties and the substantial increase in ABSD, a share deal has never looked so attractive. But this is likely to be more appealing to institutional investors such as real estate funds, who are looking to buy a huge portfolio of residential apartments already owned by special-purpose vehicles.

Move towards share deals

At the moment, there are no look-through provisions relating to ABSD or seller’s stamp duties, meaning that if an investor buys shares in a company that owns underlying residential properties, ABSD should not apply. Instead, a stamp duty would be imposed at a rate of only 0.2 per cent.

Investors may also go through a “back-door” purchase of any future residential development projects by buying into the shares of the project company, hopefully at an attractive pricing point made even more attractive without the ABSD.

As for the seller’s stamp duties, the applicable rate is determined from the perspective of the company that first purchases the residential property. Hence, by buying the shares of the property holding company instead, the seller’s stamp duties can certainly be managed, given that they only apply on a prospective basis.

For instance, let’s say a property holding company acquired residential property on Feb 1, 2010. Seller’s stamp duties for the divestment of residential property came into effect for such properties acquired on or after Feb 20, 2010. The shares in the property holding company are then sold to another company on Jan 31, 2013. When the property holding company later sells the property on Dec 31, 2014, seller’s stamp duty should not be applicable.

The same probably applies to industrial properties to which seller’s stamp duties have just been introduced. This may lead to share deals involving industrial properties becoming more common, given that most investors are likely to have incorporated an entity to hold industrial properties in order to claim back the Goods and Services Tax paid on the purchase consideration.

It is important that a share deal should be taken where there are commercial advantages too. Otherwise, there is a risk that the Commissioner of Stamp Duties may disregard or vary any arrangement to counteract any reduction in or avoidance of stamp duty liabilities.

Although the latest round of cooling measures has been called the most severe to date, there is only so much that can be done to curb speculation without causing damage to the investment climate. Singapore’s property market will continue to be attractive to global investors and real estate investments will continue to constitute a retirement nest egg for Singaporeans who can afford it.